By The Numbers: Technology Stocks With Rising Expectations

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Includes: ADBE, ALLT, AMD, APH, AVT, AVX, BB, BNFT, CRM, CTG, DIOD, ENTG, ETSY, FB, FNJN, GLOB, GLW, GOOG, GOOGL, IDTI, INTC, JCOM, LOGI, MANT, MITL, MPWR, MSTR, MU, MVIS, NTAP, NVDA, ON, PKE, QRVO, RNG, SIMO, SOL, SREV, TRMB, TWTR, TXN, UPLD, VECO, VERI, VPG, VSH, WEX, XLK, ZS
by: Andres Cardenal, CFA
Summary

Expectations can be remarkably important in the stock market, when sales and earnings estimates for a company are increasing, chances are that the stock price will increase too.

The following article is introducing a quantitative system focused on technology stocks with rising earnings and sales estimates.

Backtested performance for the quantitative system is quite strong.

Past performance does not guarantee future returns, but systems such as this one can be valuable tools for investors in for investing ideas supported by hard data and statistical evidence.

At the end of the day, a stock is simply a share in an ownership of a business. If the business is doing well, the stock will eventually do well over the long term too. However, successful investing is about much more than looking at a company's financial performance in isolation.

Stock prices reflect a particular set of expectations about the future. When those expectations are rising, chances are that the stock price will be rising too. Conversely, when expectations are moving in the wrong direction, this can put significantly downward pressure on a stock.

Let's say that there are reasons to believe that a particular company will perform better than expected in the coming year. This information can come from all kinds of sources such as industry statistics, economic variables, or data from the company's suppliers, clients and competitors.

It takes some time for such information to flow, and even more time for Wall Street analysts to adjust their earnings and sales estimates for the company based on the incoming information. Upward revisions in earnings and sales estimates are then gradually reflected on stock prices.

The main idea is that expectations and stock prices move in trends, so it makes sense to buy stocks with rising expectations. In fact, academic research has proven that shares in companies with rising earnings expectations tend to outperform the market over time.

According to data from the American Association of Individual Investors (AAII), investors following a quantitative system based on earnings expectations can obtain superior returns over the years.

The analysts at AAII have tracked a portfolio of companies with rising earnings expectations since 2003, and such portfolio has produced impressive gains. Based on data from AAII, the portfolio of stocks with rising earnings estimates has delivered an annual return of 23.9% versus an average return of 5.2% for the S&P 500 index in the same period.

Rising Expectations By The Numbers

The quantitative system is based on a ranking algorithm; this is essentially different from a screener. A screening system will invest only in companies that meet a specific parameter - for example, the increase in the average sales estimate for the current year is above 5% and the increase in earnings estimate for the current year is higher than 10%.

A ranking system, on the other hand, will rank companies in a particular universe based on the percentage increase in sales and earnings estimates, and it will invest in the companies with the higher ranking based on an average of those two indicators.

This particular algorithm is basically an average of five different variables and their fluctuation over a four week period.

  • The percentage increase in earnings expectations for the current quarter.
  • The percentage increase in earnings expectations for the current year.
  • The percentage increase in earnings expectations for next year.
  • The percentage increase in sales expectations for the current year.
  • The percentage increase in sales expectations for next year.

Companies in the investable universe are ranked in accordance to these five different factors, and then each company receives a final ranking which is an average of the five factor rankings considered.

The logic behind the system is actually quite simple and straightforward: It's all about measuring how expectations for earnings and sales in are evolving and investing in the companies benefiting from the strongest upward revisions in expectations.

Backtested Performance And Portfolio Recommendations

The following backtest picks the 50 stocks with the highest ranking of improving expectations in the tech sector, and it builds an equally weighted and monthly rebalanced portfolio with those names. The portfolio is assumed to have an annual expense ratio of 1% to account for trading expenses and slippage, and the benchmark is the Technology Select Sector SPDR ETF (XLK).

Backtested performance numbers are quite promising. Since January of 1999 the quantitative portfolio of tech stocks with rising expectations produced an average annual return of 16.68% per year, more than three times the 5.31% annual return generated by the Technology Select Sector SPDR ETF in the same period.

Data from S&P Global via Portfolio123

In cumulative terms, the quantitative system gained 1,931.3% during the backtest period, far surpassing the 174.7% cumulative gain produced by the benchmark.

To put the numbers in perspective, a 100,000 investment in the Technology Select Sector SPDR ETF in January of 1999 would currently be worth around $274,700, and the same amount of capital allocated to the portfolio of tech stocks with rising sales and earning expectations would have a much larger value of $2.03 million.

It's important to note that the backtest period includes both the explosion of the tech bubble in 2001 and the great recession in 2008, and those were tremendously tough times for tech stocks. The risk-adjusted performance metrics such as Sharpe Ratio and Sortino ratio are still clearly superior for the quantitative system versus the benchmark. This indicates that stocks with rising sales and earnings expectations can also outperform on a risk-adjusted basis through bull and bear markets.

Without further prologue, the table below shows the 50 stocks currently picked by the quantitative system in alphabetical order. Data in the table also shows market capitalization, forward price to earnings ratio, and long term growth expectations to provide a quick reference about the names in the table from a fundamental perspective.

Name

MktCap (Millions)

Fwd PE

LT Growth %

Adobe Systems (ADBE)

$124,997

37.77

18.94

Advanced Micro Devices (AMD)

$16,047

35.68

7.75

Allot Communications (ALLT)

$181

N/A

N/A

Alphabet (GOOGL) (GOOG)

$834,810

27.08

17.41

Amphenol (APH)

$26,902

25.15

9.93

Avnet (AVT)

$5,254

12.54

9.93

AVX Corp (AVX)

$3,062

23.36

N/A

Benefitfocus (BNFT)

$1,097

N/A

30

BlackBerry (BB)

$5,419

104.62

33.35

Computer Task Group (CTG)

$127

22.61

17

Corning (GLW)

$23,853

16.57

8.45

Diodes (DIOD)

$1,767

17.28

15

Entegris (ENTG)

$4,949

18.03

27.6

Etsy (ETSY)

$5,187

63.36

12.5

Facebook (FB)

$600,482

26.78

25.43

Finjan Holdings (FNJN)

$128

2.94

N/A

Globant (GLOB)

$2,070

35.39

N/A

Integrated Device Technology (IDTI)

$4,412

19.19

13.9

Intel (INTC)

$243,951

13.06

9.17

j2 Global (JCOM)

$4,237

14.47

12

Logitech International (LOGI)

$7,520

25.45

8

ManTech International (MANT)

$2,372

29.26

8

Micron Technology (MU)

$64,322

4.73

21.68

MicroStrategy (MSTR)

$1,560

57.77

32

Microvision (MVIS)

$84

N/A

N/A

Mimecast (NIME)

$2,528

136.72

20

Mitel Networks (MITL)

$1,336

10.35

25.7

Monolithic Power Systems (MPWR)

$5,910

37.72

25.74

NetApp (NTAP)

$21,527

20.03

14.55

NVIDIA (NVDA)

$152,497

32.28

21.65

ON Semiconductor (ON)

$10,050

13.24

13.08

Park Electrochemical (PKE)

$473

32.03

N/A

Qorvo Inc (QRVO)

$10,356

13.94

14.65

Renesola (SOL)

$96

9.69

N/A

RingCentral (RNG)

$6,199

126.42

27.89

salesforce.com (CRM)

$108,735

64.12

25.86

ServiceSource International (SREV)

$337

36.1

N/A

Silicon Motion Technology (SIMO)

$1,895

15.94

20

Skyworks Solutions (SKWKS)

$18,177

14.02

14.63

Spectra7 Microsystems (SPNVF)

$15

N/A

N/A

Texas Instruments (TXN)

$113,722

20.79

12.72

Trimble (TRMB)

$8,436

19.17

13.33

Twitter (TWTR)

$34,037

61.22

16.1

Upland Software (UPLD)

$778

23.3

20

Veeco Instruments (VECO)

$767

19.16

N/A

Veritone (VERI)

$282

N/A

N/A

Vishay Intertechnology (VSH)

$3,699

14.37

6.51

Vishay Precision Group (VPG)

$529

22.55

20

WEX (WEX)

$8,431

24.28

19.54

Zscaler (ZS)

$4,857

N/A

N/A

Past performance does not guarantee future returns, and the fact that earnings and sales expectations are increasing for a company does not mean that such stock will necessarily outperform the market going forward. Nevertheless, making investing decisions based on hard quantified data is a sounder approach than relying on opinions and speculations to invest in the market.

Disclosure: I am/we are long GOOG, GOOGL, FB, MU, CRM. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.